By N. Kocherlakota
The Federal Open Market Committee (FOMC) targeted a federal funds rate near zero from December 2008 through December 2015. Since September 2008, it has expanded the value of its liabilities by around five times. Yet, inflation has remained below the FOMC’s official target of 2% for most of this period and is expected to remain below 2% for several more years. These observations suggest to many that monetary policy has been impotent or ineffective over the past seven years. In this post, I argue that this negative conclusion is inconsistent with available data.
I document that from 2008-10, the FOMC deliberately aimed to keep inflation well below 2% over the medium term. (See here for a similar use of these same data.) In this important sense, there is little sign of monetary policy ineffectiveness: inflation outcomes were, in fact, largely consistent with the Committee’s relatively modest inflation objectives.
To make this point, I use the individual-level data from the Summary of Economic Projections submitted by FOMC participants at the end of each calendar year 2008-2010. (As yet, we don’t have individual-level data available after 2010.) Despite their name, these projections aren’t true forecasts. Each participant bases their submission on his/her individual assessment of appropriate monetary policy. Hence, a particular participant’s medium-term inflation projection represents that person’s medium-term goal for inflation.
In 2008, the median participant’s objective for core inflation in 2011 was 1.5%. Actual core inflation in 2011 was 1.9%.
In 2009, the median participant’s objective for core inflation in 2012 was 1.5%. Actual core inflation in 2012 was 1.8%.
In 2010, the median participant’s objective for core inflation in 2013 was 1.4%. Actual core inflation in 2013 was 1.5%.
I would say that the FOMC’s inflation track record during this (extremely difficult) period is very good. The public and markets (and the Committee itself) can have confidence in the FOMC’s ability to use asset purchases and forward guidance in an effective fashion.
There is bad news in these data, though. They suggest that the FOMC is uncomfortable with historically unusual levels and forms of accommodation. This discomfort means that the FOMC initiates the use of unconventional tools too late, and - much more importantly - seeks to terminate their use too soon. The Committee ends up aiming to undershoot its inflation objective by relatively large amounts over long periods of time.
The best reason to study the past is to learn how to do better in the future. So far, though, the FOMC has not taken these above lessons on board. In the past eighteen months, it has communicated a strong desire to “normalize” the fed funds rate and the size of the balance sheet. This desire has led the Committee to gradually tighten monetary policy in the face of strong disinflationary pressures. The result is that inflationary expectations have fallen to near-historical lows among both investors and households.
The FOMC does have the tools to forestall strong disinflationary pressures, and guide inflation back to target at an appropriately rapid pace. It’s time to use those tools.